Central banks around the world made headlines last summer as they rallied to prevent their economies from slumping as a result of the collapsing US housing market. Chairman of the United States Federal Reserve, Ben Bernanke, authorized measures not seen since the reopening of the markets following the terrorist attacks of September 11, 2001. In an attempt to steady the volatile markets, the Fed injected more than $60 billion into that country’s financial system over several days.

Across the Atlantic, acting on the same fears of a global market collapse, the European Central Bank went even further, pumping nearly $200 billion into their system. The measures worked, at least in the short term, but some economists later criticized the executive board of the European Central Bank, led by bank president Claude Trichet, of overreacting out of panic.

While all of this was transpiring, Wendy Craigg, now governor, then chair, of The Central Bank of The Bahamas, remained calm. The Bahamian economy, stable and robust for its small size, remains relatively insulated thanks to one critical factor: exchange controls. “We have a fixed exchange rate environment. In other countries where there’s a flexible exchange rate you will tend to see the central banks intervening in the foreign exchange market to influence the level of the currency,” explains governor Craigg.

When necessary, the Central Bank adjusts interest rates to influence liquidity when credit grows at a pace where it could jeopardize the level of foreign reserves. Foreign reserves are a key factor enabling the country to maintain its one-to-one parity with the US dollar—a situation Bahamian authorities have managed to sustain since the one-time British colony switched from sterling in 1966. Because the Bahamian dollar is pegged to that of the US, to a large degree, their economy is impacted by decisions made by the US Fed.

Central Bank mandate
Part of the institution’s mandate is to ensure Bahamian monetary stability, and the same exchange controls that insulate the country from the external shocks to which other economies are highly susceptible play a major role in the Central Bank’s overall responsibilities.

The bank has numerous other functions, all designed to keep the Bahamian economy on an even keel and ensure the country’s reputation as a leading financial services jurisdiction. Bank supervision is a major responsibility, given the preponderance of global banking institutions with a presence in the country. Governor Craigg and her team supervise and regulate the banks to ensure that the financial services sector remains robust. It is their job to maintain an environment that continues to attract high-quality institutions and reputable clients.

The Central Bank of The Bahamas is also heavily involved in the country’s payment system, which lies at the heart of the domestic banking industry. In recent years, the bank has played a key role in creating the country’s Real Time Gross Settlement System as well as the Automated Clearing House, which will link all banks operating within the country. They also have an active research department that analyses national economic developments and disseminates the information on a consistent basis so that the government, financial services sector, investors and members of the public can make sound financial decisions.

The future of exchange controls
By far the biggest challenge for the institution and for the country, however, is expected to come within the next five years: the elimination of exchange controls. The Hubert Ingraham administration came to power in May 2007 with a pledge to abolish exchange controls entirely during his term in office. This is not the first time the idea of relaxing controls on Bahamians’ use of foreign currency and direct interaction with global markets has been proposed, but it is certainly the most serious effort to date.

Under current rules, Bahamians wishing to travel can satisfy their foreign currency requirements by going to a commercial bank and filling out a simple form. The per-person maximum is $10,000 per trip and there is no limit to the number of trips an individual can take each year.

However, Bahamians are not free to invest overseas or own foreign assets. To invest in a foreign stock market, Bahamians must pay a premium of 12.5 per cent on the dollar; converting back, they get 10 per cent on the same dollar. “You have to make a gain of 2.5 per cent just to break even, so you want to be very confident in your investment,” notes governor Craigg.

Former Central Bank governor Julian Francis admits the system places some limits on Bahamians’ ability to generate wealth, but notes that it also serves a purpose. “There are some disadvantages to it, absolutely,” he says, “but there are also some important reasons why we ought to dismantle it very carefully. I don’t think anybody disagrees today that it ought to be dismantled; the issue is the pace of doing so.”

Governor Craigg agrees wholeheartedly with the movement toward gradual relaxation, but wonders if those pushing for the freedom fully understand the potential risks and implications. “I don’t know if the people calling for the relaxation of exchange controls understand the pros of our current situation. If we weren’t so insulated we would have been far more impacted by what went on with the global markets on a much more direct and personal level and much more quickly,” she says.

Although the government has promised to eliminate exchange controls within the next five years, Craigg says realistically that can only happen if the level of foreign reserves, the level of the nation’s debt and the overall fiscal situation improve. “We are moving in the right direction. The economy is growing at a very stable pace in terms of GDP growth and the prospects are positive for future growth, particularly when you look at all of the projects that are in the pipeline.” As long as there is a gradual move and institutions and individuals are educated and prepared to handle the new risks devoid of that Central Bank buffer, she is confident that The Bahamas will soon be ready to completely eliminate exchange controls without ever skipping a beat.